iFlow > Short Thoughts
Published on Tuesdays, Short Thoughts offers perspectives on US funding markets, short-term Treasuries, bank reserves and deposits, and the Federal Reserve's policy and facilities.
John Velis
Time to Read: 5 minutes
EXHIBIT #1: NO BIG RATE MOVES EXPECTED INTO 2027
Source: BNY Markets, Bloomberg
EXHIBIT #2: INFLATION EXPECTATIONS WELL BEHAVED
Source: BNY Markets, Bloomberg, Federal Reserve Bank of New York, University of Michigan, Conference Board
We expect no action on Wednesday at what is very likely to be Fed Chair Jerome Powell’s last meeting as FOMC chair, with uncertainty pervading and the Iran conflict still far from resolution. Forward guidance will also be scarce given the inability to form high conviction views on the inflation outlook. Although the rate decision itself – no change in policy is expected – will be trivial, the press conference afterward could shed some light on Chair Powell’s plans after May 15.
Exhibit #1 shows that since the conflict began, rate expectations through the end of the year and even into 2027 are nearly flat. This is probably an accurate depiction of the two-sided risks in the economy and the market’s inability to form a high-conviction view on the rates path, very similar, in our opinion, to the FOMC’s own uncertainty.
It’s interesting – and from the Fed’s point of view, encouraging – that inflation expectations appear to be well contained, especially in the long term. But even shorter-term expectations have not increased materially. Exhibit #2 shows the change in the most recent inflation expectations versus their 2025 average for market-implied measures as well as survey data.
We plot the change in inflation expectations for the 1y inflation swap, the 2y breakeven inflation rate, the New York Fed Survey of Consumer Expectations, the Michigan Survey of Consumers, and the Conference Board Consumer Confidence Survey. These show that over short horizons there has been only a very modest rise in short-term inflation expectations, although of the surveys, only Michigan shows data for April.
For longer-term expectations, we plot the 5y5y inflation swap, the 10y breakeven, the NY Fed’s 5y expectations survey and the Michigan survey. At this longer horizon, we see much more subdued reactions. The 5y5y swap is actually lower now than its 2025 average, as is the Michigan survey, although the latter’s April data is due on May 8. The general impression, then, is that market participants have not priced lasting inflation from the Strait of Hormuz closure. This allows the Fed to relax on the short-term inflation outlook. When the waterway opens, we would expect these short-term inflation expectations to move lower, eventually giving the Fed cover to cut rates late in 2026 should the labor market weaken further from its current zero-growth equilibrium.
EXHIBIT #3: WARSH NEARLY CERTAIN, POWELL LESS SO
Source: BNY Markets, Polymarket
Last Friday morning, the U.S. Department of Justice (DOJ) dropped its criminal probe into the Fed’s building renovation project. Over the weekend, outgoing Republican Senator Tillis from North Carolina changed his position and declared that he would now vote to move Kevin Warsh’s nomination through the Banking Committee and to the full Senate. Warsh is now expected to be confirmed to his post in coming weeks, in time for Chair Powell’s official end of term on May 15.
Above, in Exhibit #3, we show the prediction market’s evaluation of Warsh’s odds to be confirmed by May 15. Compared to last week, the markets are almost sure that he will be confirmed by the 15th, reflecting the change in circumstances. We also show the odds that the prediction market views a Powell departure from the Fed by May 30. While they are somewhat higher than they were at the end of last week (around 28%), they still are not overwhelmingly pricing in the outgoing Chair’s departure by the end of next month, reflecting just a 42% chance.
It’s possible, if not likely, that Chair Powell will be asked his intentions at Wednesday’s press conference, but we’re not convinced we’ll get a definitive answer. We were somewhat surprised that he volunteered his thinking in last month’s presser, so we don’t exclude the possibility of some news this time around.
While it would be unprecedented for an outgoing Chair to remain on the Board until their term ends (Powell’s term officially expires in January 2028), we are in unprecedented times. It’s only happened twice in history for an outgoing chair to stay on the Board. Powell may feel that the end of the probe can allow him to leave in good standing, but the DOJ’s comment that they could reinitiate it at any time might change his calculus.
Whatever Powell’s fate, it’s a near foregone conclusion that Warsh will chair the Board of Governors soon. As we pointed out when he was first nominated, a Warsh Fed is likely to lean dovish, although the current circumstances are highly likely to preclude any swift rate cuts, as discussed above. Even if he did advocate for easing, the rest of the FOMC needs to be convinced to support such a move – unlikely while the Iran conflict is ongoing and uncertainty persists.
In addition, between his paper trail and his confirmation hearing last week, it’s clear Warsh will lead the Fed into a new era institutionally. He has talked about reining in Fed communications with the public and has looked askance at forward guidance. Balance sheet policy will be addressed, as we discuss frequently in this piece, although we and the markets are skeptical that this process would be swift. Warsh has advocated for the Fed to “stick to its knitting,” and he will likely reshape the research agenda to focus on narrow questions of monetary policy and macroeconomics. Finally, Warsh has discussed relations between the U.S. Treasury and the Fed, including a “new accord” to coordinate balance sheet policy and issuance practices. Even if monetary policy remains on hold until at least much later in the year, the months ahead will see lots of activity for the Fed across the range of its functions.
We don’t think the likely Warsh transition will lead to significant policy changes in the very near term, as long as the conflict with Iran continues. We have been on record advocating for two cuts in Q4, conditional on the Strait of Hormuz reopening. If this were to happen before, say, the end of the summer, we could see a Warsh appearance at the Jackson Hole Symposium in August lay the ground for upcoming easing.
We admit that the longer the Strait remains impassable, the less conviction we have in our two-cut call. We base our view on a very uncertain assumption as well as uncertain timing. We think this is why the curve shown in Exhibit #1 is equally unconvicted, expecting practically no moves through March 2027, with a slight bias toward a cut.
This week will provide several important March data releases for the U.S. economy, presumably reflecting the impact of the war and the energy shock. Data on Q1 GDP, personal consumption, consumer inflation, and durable goods orders are all to be released, among several other “second tier” data points.
